Analysis: Next correction could send oil towards $140

By

Serge Laureau

PublishedMonday, June 09, 2008

What a difference a few days can make. On Wednesday, in a market first, a Federal Reserve Governor made comments on the US dollar (a task normally delegated to the Secretary of Treasury) in a bid to strengthen the currency. Two days later Jean-Claude Trichet, President of the European Central Bank posted a rate decision speech highlighting a possible rate hike soon, sending the dollar lower again.

It has been a roller-coaster ride for traders and with the exception of day traders, some money managers could not keep up with the speed of change.

We have been questioning the $125 oil price for some time now and after falling more than $10, the recent bearish sentiment unwound very quickly.

WTI July crude oil is trading again above the $130 level, following the sharp $6 rally on Thursday and the even stronger rally on Friday as the dollar came under pressure in the wake of hawkish comments from Trichet, which put markets on heightened alert for a July rate hike.

Oil has maintained a reasonably regular pattern since last June when it reached $70: it hits a new record, then retraces by around $10 then lures the bears in and then the bulls spring the trap and bid the price to another new record.

Oil bears have faced another test and successfully passed it. However, the recent weakness could be another bull correction and send oil towards $140.

Whatever the near term pattern, we maintain our bearish view as we still believe the fundamentals are not correctly priced in. But we have to take into account the market short term trend. The run up to the summer season should lend oil support, despite declining petrol demand in the United States, and the probabilities are favouring a spike in energy usage with the start of the hurricane season and geopolitical risks again rising to the fore.

Importers buy up wheat

The wind-up of last week saw wheat futures rise for a third day on dollar weakness and as importers, including Japan and South Korea, sought to buy the grain following a sharp decline in the price. However, wheat prices dropped 44 per cent from a record $13.49 in February as farmers increased seeding of the grain.

Japan bought 153,000 metric tonnes of milling wheat, the most since February. South Korea purchased 165,000 tonnes of feed wheat in private trades last month, the first such purchases in more than a year, and it may buy more. South Korea, the top corn buyer after Japan and Mexico, is forecast to import nine million tonnes of corn in 2008/09, including 7.2 million tonnes for feed, while it is expected to buy 500,000 tonnes of feed wheat, according to the US Department of Agriculture.

Compared with the current prices of corn and soybeans, the wheat price has fallen further from its record highs and there has been good buying interest below $7.50 a bushel for wheat. With countries harvesting bumper wheat crops, some demand for corn to feed livestock may be replaced with feed wheat. Wheat July contract is capped at $805 for now and we will look at price action around this level.

Bund yield curves hit hard

The front-end of bund yield curve has been hit badly in the wake of Trichet's press conference, with fast money accounts dumping the front-end, while real money accounts have barely had a chance to re-assess the curve strategy.

We are not convinced the yield curve price changes, which are inverted for now, reflect a weakening European economy.

Trichet's credibility is in the firing line. If the ECB hikes rates at the next meeting in July he will have to revisit the stance and lower rates a few months later in the course of a weaker European economy.